Tagged: IR

Mercenary Prices

Florida reminded us of high-speed traders.  I’ll explain.

An energized audience and the best attendance since 2012 marked NIRI National, the investor-relations annual confab held last week, this year in Orlando.

We spent the whole conference in the spacious and biggest-ever ModernIR booth right at the gateway and in late-night revelry with friends, clients and colleagues, and I don’t think we slept more than five hours any night.  Good thing it didn’t last longer or we might have expired.

I can’t speak to content because we had no exposure. But asking people coming through the exhibit hall what moved them, we heard about IEX CEO Brad Katsuyama’s general session on the state of markets (we said hi to Brad, who was arriving in from New York about 1am as we were wrapping for the night and heading to bed).

“He said the exchanges are paying $2.7 billion to traders.”

That what folks were reporting to us.

You remember how this works, longtime readers?  The big listing duopoly doled out $500 million in incentives to traders in the most recent quarter.  That is, exchanges paid others to trade on their platforms (the rest came from BATS Global, now part of CBOE).

Both exchanges combined earned about $180 million in fees from companies to list shares. Data and services generated a combined $750 million for the two.

There’s a relationship among all three items – incentives, listing fees, data revenues.  Companies pay to list shares at an exchange. The exchange in turn pays traders to set prices for those shares. By paying traders for prices, exchanges generate price-setting data that brokers and market operators must buy to comply with rules that require they give customers best prices.

I’m not ripping on exchanges. They’re forced by rules to share customers and prices with competitors. The market is an interlinked data network. No one owns the customer, be it a trader, investor or public company. Exchanges found ways to make money out there.

But if exchanges are paying for prices, how often have you supposed incorrectly that stocks are up or down because investors are buying or selling?

At art auctions you have to prove you’ve got the wherewithal to buy the painting before you can make a bid. Nobody wants the auction house paying a bunch of anonymous shill bidders to run prices up and inflate commissions.

And you public companies, if the majority of your volume trades somewhere else because the law says exchanges have to share prices and customers, how come you don’t have to pay fees to any other exchange?  Listing fees have increased since exchanges hosted 100% of your trading.  Shouldn’t they decrease?

Investors and companies alike should know how much volume is shill bidding and what part is real (some of it is about you, much is quant).  We track that every day, by the way.

The shill bidders aren’t just noise, even if they’re paid to set prices. They hate risk, these machine traders.  They don’t like to lose money so they analyze data with fine machine-toothed combs.  They look for changes in the way money responds to their fake bids and offers meant not to own things but to get fish to take a swipe at a flicked financial fly.

Take tech stocks.  We warned beginning June 5 of waning passive investment particularly in tech. The thing that precedes falling prices is slipping demand and nobody knows it faster than Fast Traders.  Quick as spinning zeroes and ones they shift from long to short and a whole sector gives up 5%, as tech did.

Our theme at NIRI National this year was your plan for a market dominated by passive investment.  Sometime soon, IR has got to stop thinking everything is rational if billions of dollars are paid simply to create valuable data.

We’ve got to start telling CEOs and CFOs and boards.  What to do about it? First you have to understand what’s going on. And the buzz on the floor at NIRI was that traders are getting paid to set prices. Can mercenary prices be trusted?

Predictive Knowledge

Why don’t I trade like my peers?

The CEO is sure it’s because investors don’t understand something – how you manage inventory, your internal rate of return targets. Pick something.

Investors ask the same question. Why does that stock lag the group? For answers, they root through financials, technology, leadership, position in the market, to find the reason for the discount (or opportunity).

What if these assumptions are wrong?

At prompting from friend and colleague Karla Kimrey in the Rocky Mountain NIRI chapter (which we sponsor) who knows I’m a data geek, I’m reading Michael Lewis’s The Undoing Project, his latest. It’s a sort of sequel to Moneyball, about how baseball’s Oakland A’s changed professional sports with data analytics (read both and you’ll see that ModernIR is Moneyball for IR).

The Undoing Project focuses on why incorrect assumptions prevail.  I don’t have the punch line yet because I’m still reading. But I get the point already and it’s apropos for both investor-relations professionals and investors in markets that often seem to defy what we assume is the rationale behind stocks and the whole market.

Perception overwhelms reality.

The CEO, the IR professionals, investors, are all focused on the same thing. The collective assumption is that any outcome varying from expectations is a deficiency in story.  Personal perceptions have shaped our interpretation of the market’s behavior.

Yet statistically, rational thought is a minority in market volume – about 14% of it, give or take. When markets surged Monday, the Dow Jones Industrials up 183 points, we were told it was enthusiasm about earnings.

The data showed the opposite – Asset Allocation. Money that pays no attention to earnings. It’s 33% of market volume.

Why would it buy now? Because options are expiring today through Friday (and derivatives directly influence 13% of trading volume marketwide).  Asset Allocation uses options and futures to nimbly track benchmarks, and with markets down it’s probable that derivative positions were converted to the actual stocks.

But then it’s over.  Mission accomplished.  Yesterday the market gave back 114 points to go with 138 points last Thursday. The qualitative assumption – the gut instinct – that earnings enthusiasm lifted stocks Monday was not supported by subsequent data.

Daryl Morey, general manager of the Houston Rockets, gives The Undoing Project a literary push in the early pages. An MIT man and not a basketball player, Morey came into the job because team owner Leslie Alexander wanted “a Moneyball type of guy.”

He sought data-driven results.  And it worked.  Houston is in the top ranks for success with draft picks and getting to the playoffs, and other teams have copied them.

Morey says knowledge is prediction. We learn things to understand what may happen. It’s a great way to think about it. Suppose it works in IR and investing too.

It starts with questioning assumptions.  What gut instincts do you hold about your stock that you can’t support with data?  How do they compare to the data on market volume?

I know there’s a swath of people in every walk including IR and investing who think data is BS. Who cares? they’d say.  I go with my instincts. Besides, what difference does it make if we know or don’t?

Knowledge is prediction. Data align perception and reality. In Undoing, Lewis uses the Muller-Lyer illusion. Your mind perceives one line longer. Nay. Measurements prove it.

I’ll leave you with this data on the market. I wrote last week about volatility insurance.  Now we’ve got volatility.  Insurance policies are expiring right now, with the VIX today kicking off April expirations through Friday. Our Sentiment Index trend is like mid-2014.

We don’t know what may come. But we’re thinking ahead. Assumptions are necessary but should be the smallest part of expectation.

That’s a good rule of thumb in life, investing and IR (and if you want help thinking about what IR assumptions may be wrong, ask us. We may not have the answer. But we’ve got great data analytics to help sort reality from perception).

Do The Math

Anybody ever said to you, “Do the math?”

Yesterday on CNBC’s Squawk Box legendary hedge-fund manager and founder of Omega Advisors Leon Cooperman said the world is crazy.  That’s anthropomorphizing the planet but I agree. He was referring to the math behind negative interest rates, which means paying people to borrow money.  That’s crazy all right, but happening.

He also said, paraphrasing, that if the population of the country grows by 0.5% and productivity increases by 1.5%, that’s 2% economic growth.  Add in 2% inflation and you have 4% “nominal” growth, meaning the numbers add up to that figure.

He said if the S&P 500 trades at 17 times forward earnings, that puts the S&P 500 at roughly 2150, about where it is now, so the market is fully valued but not stretched.

Why should you care in the IR chair? Macro factors are dominating markets, making a grasp on economics a necessary part of the investor-relations job now.

Whether Mr. Cooperman would elaborate similarly or not, I’m going to do some math for you.  Inflation means your money doesn’t go as far as it did – things cost more.  If a widget costs $1 and the next year $1.02, why? Prices rise because the cost of making widgets is increasing.

Making stuff has two basic inputs:  Money and people. Capital and labor.  If you must spend more money to make the same stuff, then unless you can raise prices or reduce the cost of labor, your margins – which is productivity or what economists call the Solow residual – will shrink.

There’s no growth if you’re selling the same number of widgets, even if revenues increase 2%. And if prices rise, there is on the fringe of your widget market some consumer who is now priced out. That’s especially true if to retain margins you cut some labor costs by letting the receptionist go.  One more person now can’t buy widgets.

And so sales slow.

The Federal Reserve is tasked with keeping unemployment low and prices stable (a bad idea but that’s another story). Its strategy is to increase the supply of money, the theory being more money prompts hiring and rising prices are better than falling prices (errant but again for another time).

One simple way to see if that’s occurring is to look at currency in circulation on the Fed’s balance sheet.  There is now $1.5 trillion of currency in circulation, up $82 billion from a year ago.  Our economy is growing at maybe 1.5%.

In 2000, US GDP growth (right ahead of the bursting Internet bubble) was 4.1%.  In 2000, currency in circulation was $589 billion, down $30 billion from 1999 when currency in circulation grew by $100 billion over the previous year. It increased $35 billion in 1998, $31 billion in 1997.

For 2013, 2014 and 2015, currency in circulation grew $74 billion, $80 billion and $97 billion, and since July 31, 2008, before the financial crisis, currency in circulation is up $645 billion, more than total currency circulating in 2000.

Back to economic basics, what happens to the cost of stuff if money doesn’t go as far as it used to?  Prices rise.  Okay, the Fed is achieving that aim. Its plan for remedying the recession was to get prices rising.

But rising prices push some people out of the market for things.  And if to make things you’ve got to put more money to work, then something has to give or productivity declines.

It’s declining.

And if stuff costs more, people who aren’t making more money can’t buy as much stuff.  What you get is weak wages, weak growth, weak productivity. Check, check, check.

Haven’t jobs numbers been solid? We have 320 million people in this country of which 152 million have jobs. If 1% leaves every year for retirement, having kids, going to school and so on, 200,000 jobs each month is 1.5% economic growth at best.

And that’s what we’ve got.

If you want a realistic view of the economy, do the math.  At some point the rising cost of things including stocks and bonds will push some consumers out of the market.  The only head-scratching thing is what math the Fed is doing, because its math is undermining, jobs, economic growth and productivity.  It seems crazy to me.

Three Acts

Spain rocks.

We’re back from pedaling the Pyrenees and cruising the rollers of the Costa Brava on bikes, where the people, the food, the wine, the scenes, the art, the land and the sea were embracing and enriching.

To wit, we traversed 200 miles, thousands of feet of climbing and even walked some 40 miles around Barcelona and Girona and I still gained weight. But I wouldn’t trade a bite of Jamon Iberico or sip of rich red Priorat (I’ll let you look those up!).

After a night home we’re now in Chicago where I’ll speak today to the Investor Relations council for MAPI, the manufacturers’ association, on market structure, and tomorrow we’re in Austin for the NIRI Southwest Regional Conference where we sponsor and I’ll aim to rivet attendees with how IR should navigate modern markets.

Speaking of which, a perspective as September concludes this week that’s shaped by two weeks away and abroad might best work as journal entries:

Journal Entry #1:  CBOE to buy Bats Global Inc.

Years ago I sat in front of Joe Ratterman’s desk in the unassuming Lenexa, KS, BATS offices and talked about things ranging from market structure to Joe’s fondness for aircraft.  Joe is now chairman and should be able to afford a bigger plane.

But the thing to understand here is how the combination is a statement on markets. Derivatives and equities are interwoven with other asset classes. It’s what the money is doing. The market is a Rubik’s Cube where moving one square impacts others and strategies for traders and investors alike manifest in complex combinations (you clients see this all the time in our Patterns view in your Market Structure Reports).

The IR job is about building relationships with long-term money, sure. The challenge is to understand the process and method through which money moves into and out of shares. Without knowledge of the process and method, comprehension wanes – and it’s incumbent on IR to know the market. Investors and traders are not mere buyers or sellers now. Profit and protection often lie in a third dimension: Derivatives.

Journal Entry #2: The Tick Size Study. 

We reflected back to 2014 last week and revisited our comments from December that year. The exchanges at the behest of the SEC are at last embarking next month on a study of bigger spreads for buying and selling small-cap stocks to boost trading activity.

It’s a fundamentally correct idea except for one problem. And you’d think, by the way, that the Federal Reserve could grasp this pedestrian concept. Where spreads are narrow, products and services commoditize and activity moves to the path of least resistance. You understand? Low interest rates shift focus from long-term capital investment to short-term arbitrage.  Low market spreads do the same to stocks.

But the problem is the National Market System. It’s an oxymoron. Something cannot simultaneously be a market – organic commercial interaction – and a system – a process or method.  There’s either a market, or a process and method. The SEC wants to tweak the process and method to revitalize organic commercial interaction. Well, if organic commercial interaction is better, why not just eliminate the system?  The Tick Size Study is a good idea trapped within a process and method that will likely desiccate it of benefit.

Journal Entry #3:  The Market.

It too is matriculating in a process and method.  We had the Great Recession, as those who take credit for halting say.  The process and method for constraining it (for now) could be called the Great Intervention.  The third step is the Great Risk Asset Revaluation, currently underway.

In August 2014 the Fed’s balance sheet stopped expanding as the Great Intervention that followed the Great Recession halted.  In latter 2014 the stock market stopped rising. So long as the Fed’s balance sheet increased, the supply of money via credit did too, and that money chased a decreasing supply of product – stocks (because public companies are buying back more shares than they issue, collectively).  There are today fewer public companies than in 2008.  Stocks are trading roughly where they did in December 2014.

Something to ponder:  Generally when growth stocks experience slowing revenues (see Twitter for instance) or earnings, shares fall. The stock market has been in a year-long recession for both. Never in modern history has the economy not also been in recession when that occurred, nor has the market failed to retreat. That it hasn’t is testament to the inertia – a tendency to remain in a uniform state of motion – created by Intervention.

It’ll stop. And stop it must.  We’ll never have a “normal” market until then, so see it cheerfully and not with fear (inertia can last a long time too). Catch you in October.

Gilding the Trend

Is index-investing the death knell for investor relations?

According to S&P Dow Jones – which, you REITs, will be breaking out your sector from Financials Aug 31, as will MSCI – over the ten years ended Dec 2015 a staggering 98% of all active investment managers in the USA underperformed the S&P 500.

These outfits are indexers and will make the case for models. But there’s an obvious rub for the profession pitching stories to stock-pickers.  If the folks listening are trailing the benchmarks, investors will move to passive investing.  And they are, in droves. If your team loses all the time, people quit coming to the games.

There’s a tendency in the IR profession to want to shove our heads in the sand about this disturbing condition.  If we can keep quiet, keep doing what we’ve done, maybe the problem will go away or management will remain unaware of it.

That’s no strategy!  Let me gild this trend in gold for the IR profession. Who is our audience?  The money.  Right?  The IR goal is a well-informed market and a fairly valued stock.  So long as you have measures (and we do here at ModernIR!) that will tell you when these conditions exist and how to keep them there, there’s no need for stress at the state of stock-picking.

Make no mistake:  Telling the story will never go away. We need the Active demographic. You have to cultivate a diverse set of styles among stock-pickers. But it can no longer be your sole endeavor. Where 25 years ago the dominant force was bottom-up investing, today’s principal price-setting investment behavior is Asset Allocation – indexes and exchange-traded funds.

Fine! So be it.  The IR profession must adapt.  We’ve seen evolution in the role over the past decade with a swath of public companies giving IR auxiliary duties ranging from communications to financial planning and analysis. Now IR must add data analysis.

Let me explain. If the money is following models, then model the money.  You can’t talk to that sort of investment about what distinguishes you.  Blackrock and Vanguard don’t listen to earnings calls. Who cares? You can track money quantitatively with a great deal more accuracy and a whole lot less work to boot than trooping all over the planet seeing stock-pickers, most of whom will fail to perform as well as SPY, the world’s most actively traded equity – which is a passive investment.

We live in a world where data and technology have converged everywhere from your kitchen to your retirement portfolio. It’s time the IR profession caught up.  Invesco owns PowerSharesJanus owns VelocityShares. The buyside is adapting. We’d better, too.

So what should you do?  The simplest, easiest and most affordable solution is to use Market Structure Analytics, which we invented to demographically profile all the money driving your equity. You can know every day what percentage of your volume is from Asset Allocation (and three other big behaviors).

Not everyone can, I realize! If nothing else, start today educating your management about ETFs.  Go to alletf.com and find out how many are associated with your shares. Explain that investments of this kind are dominating equity inflows, and consider it a badge of honor if they’ve got more than 5% of your equity collectively.

There’s a lot to grasp about ETFs. And if you’re a longtime reader you know my rub with them: They’re derivatives. Set that aside for now.  Our profession must shift from defense to offense.

It begins with leading management into the equity market we’ve got rather than letting them discover it themselves. They’ll wonder why you didn’t explain it.

Buy the Rights

Know the song by OMC?  Jumped into the Chevy. Headed for big lights. Wanna know the rest? Hey, buy the rights.  How bizarre, how bizarre…

The market-structure mashup recently took a somewhat bizarre turn. InterContinental Exchange, owner of the NYSE, bought the rights to high-speed trading patents.

Said David Goone, ICE’s Chief Strategy Officer: “ICE acquired these patents with the goal of preventing third parties from using these intellectual property rights against our customers. ICE intends to make these patents available broadly for license to customers that provide beneficial liquidity in ICE’s and NYSE’s markets.”

ICE says the patents are for an automated trading system that makes pricing and trading decisions based on market-price information, and the associated intellectual property covers electronic trading in both derivatives and stocks.

What makes it odd at first blush – but certainly clever – is ICE’s opposition to high-speed trading. “You shouldn’t pay people to trade,” ICE CEO Jeff Sprecher said in October 2013, voicing dislike for the system where exchanges pay brokers for trades that create liquidity attractive to orders from others. To oppose high-speed trading and then buy patents customers can use to bring high-speed liquidity-producing trades to the NYSE seems smart but contradictory. (more…)